A Huge Gas Gamble That Went Poof

 | Apr 25, 2014 | 6:00 PM EDT  | Comments
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Stock quotes in this article:

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lng

Everyone seems to be talking about natural gas prices. They start by pointing to shale gas and claim prices are low. This sound bite is repeated over again until it becomes an accepted statement, undeserving of a challenge.

It is not true. Looking at Energy Information Administration (EIA) data, natural gas prices are up, and they are up substantially. In fact, natural gas may no longer be economic for some consumers.

Wellhead and retail prices are up year-over-year. Wellhead prices and retail prices for nine states and the District of Columbia have merged and put into one graph (some of the 2013 and 2014 data have been estimated). It is clear; all prices are up from where they were a decade ago:

Sources: EIA/Williams

The graph illustrates some important points. Commentators are right when they say natural gas prices are low if their reference is prices for years 2004 to 2009. They are wrong if they pick any other year.

Here is why it is important. Lobbyists for the coal and nuclear industries are complaining that low natural gas prices are hurting their business. They are also arguing that government subsidies for renewable energy resources are unfair and they want them abolished.

It turns out their real argument is not that prices are low compared to historical trends. Prices are low compared to where they were expected to be. Let me explain.

In the late 1990s, policymakers and energy executives thought North America was running out of natural gas. Most expected that the U.S. would be forced to import natural gas from foreign sources. As a result, a dozen liquefied natural gas (LNG) import terminals were built in the Gulf of Mexico and up the East Coast. They cost billions to build, but they were sure to deliver a profit. It was clear demand was growing and supplies were about to evaporate and gas prices had to jump.

Utility executives were looking at the same data. They saw a different opportunity. They thought if natural gas prices jumped from $3 to $20, wholesale power prices would follow. If they owned generating assets with low production costs, their margins would explode. Companies like Exelon (EXC), Entergy (ETR), Dominion Resources (D), NextEra (NEE) bought up used nuclear power plants. Because utility deregulation was occurring about the same time, they were able to acquire used nuclear plants for pennies on the dollar.

The same pattern appeared in the coal industry. Companies like Edison International (EIX) and PG&E (PCG) bought up used coal plants for pennies on the dollar. They too expected growing margins as power prices drifted higher.

After most of the acquisitions were done and put to bed, LNG owners and power producers sat back and waited for gas prices to explode. They did not have to wait long. By the mid-2000s, the once stable gas industry became volatile. Prices started to climb, and then they jumped. Spot natural gas prices spiked past $10.50. And, as executives expected, power prices followed suit.

Then, shale gas hit the market. Nuclear and coal executives started to realize their payday was fading. More shale gas appeared and it looked like natural gas was here to stay. LNG, nuclear power and coal assets slipped into the red. One by one, assets became stranded.

Cheniere Energy (LNG) and Dominion were able to convert their LNG terminals into export facilities. By investing additional capital and selling off future production, they were able to recover some of their stranded assets.

Independent power producers were not so lucky. They were stuck with unprofitable coal and nuclear units. They expected gas turbines would be pushed out of the market. Instead, they found themselves near the margin and unable to clear auctions.

Now, tens of thousands of megawatts of coal and nuclear power are stranded. Most are unable to deliver cash flows, let alone earnings. Producers cannot sustain losses. If natural gas prices remain at normal levels, these assets become permanently uneconomic.

Now, power producers are warning federal, state and local governments. They may be forced to retire assets early. As their assets retire, tens of thousands of jobs and a large tax base also retire.

It is not about natural gas prices being unusually low; it is about a huge gamble that went terribly wrong. That gamble amounted to tens of billions of dollars.

Investors should brace themselves for some big retirement announcements. It will not be limited to coal. It will include nuclear and other generating assets.

Exelon and Entergy could announce the early retirement of 10 to 20 nuclear plants. Meanwhile, other producers are announcing early retirements of dozens of coal plants. Until these surplus units are gone, expect volatility with power producers.

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